Sunday, 11 May 2008

Well-being and Judgement

Charles Kindleberger summed up the problem perfectly. “There is nothing as disturbing to one’s well-being and judgment as seeing a friend getting rich.”

Here in the UK, over the last ten years, envy, greed and fear tested the limits of “well-being and judgment." With house prices increasing at double-digit rates, it has been hard to stand back and question the sustainability of this explosion of wealth.

It was almost impossible to take a contrarian view on housing since the country was primed for speculation. TV channels devoted hours of programming that pumped up housing optimism. The central bank cut rates to historically low levels. Banks had forgotten about risk and were ready to lend. The financial supervisor was asleep. Even the government statistical service produced numbers confirming that household wealth had doubled in a decade.

Unfortunately, far too many people succumbed to the wealth creating euphoria of housing inflation. To be truthful, it is easy to understand why. It is hard to sit out a speculative mania, particularly when everyone else around you appears to be growing richer. It was easier to run with the herd as it raced into banks demanding mortgages and investing in buy-to-let. With the herd moving with such momentum, it was almost impossible to say no to housing.

Housing mania led UK households into investing, borrowing, and consuming at unprecedented rates. They dived into the buy-to-let investment industry, with scant regard for the risks. They swarmed across Europe, buying up cheaply constructed holiday homes. Until recently, households could discount their growing levels of personal indebtedness by appealing to the overall health of their balance sheets. Housing equity trounced debts every time. The market had made homeowners rich, at least on paper.

However, what happens to well-being and judgment when that paper wealth begins to evaporate and friends start to become poor? Is envy replaced by gloating as the the housing market transforms into a malign wealth destruction mechanism?

Unfortunately, well-being does not recover during a housing crash. People may have stopped bragging about house prices. An icy silence may have replaced the boasting. Nevertheless, this silence has not dissipated the growing fog of financial pressure.

The housing calamity is growing by the day. For those of us who avoided any entanglement in housing, there is little comfort in seeing others suffer. Gloating is a poor substitute for envy. It is, however, a good time for judgment, particularly if it leads to permanent changes that ensure that housing bubbles never happen again. Now is the time to radically reform the housing market.

We could start by liberalizing planning regulations. A new zoning system would be the ideal, defining all property according four types: industrial, agricultural, commercial, and residential.

Once a property has received its zoning, owners should be allowed to develop the land as they see fit. One immediate benefit would be better use of high value residential land by clearing the existing dilapidated Victorian housing stock and replacing it with more high-density housing. Reforming planning procedures would simultaneously reduce housing prices, increase housing supply, and generate a construction boom.

Second, we should introduce a national land tax. This would result in a more equitable tax system and discourage housing speculation. The tax should have particularly onerous rates on empty properties and idle land, which would again discourage speculation.

Third, the estate agent industry is in desperate need of reform. Customers need more transparency and honesty. In future, agents should be forbidden from giving any form of ill-informed investment advice. All offers on a house should be publicly disclosed, to prevent fraudulent price wars.

Finally, banks need tighter regulation. The FSA is manifestly incapable of controlling the banking sector. It should be abolished with its supervisory responsibilities returned to the Bank of England.

The housing bubble stretched every indicator linking house prices to sensible fundamentals. These fundamentals are reasserting themselves and the market is now turning into a wretched debt soaked mess. The crash will create enormous financial pain, and it is too late to save those friends who took on too much debt, remortgaged to finance excessive consumption, or who were suckered into a money losing investment after an inside track seminar. It is not too late, however, to prevent this kind of crisis from reoccurring in the future.

These four reforms would indeed sort out 90% of the problem, and by keeping property prices low and stable, would go a long way to preventing booms'n'busts in the real economy.

But *ahem*. 83% of us are NIMBYs. People don't understand the beauty and simplicity of LVT. We live under a quangocracy. It's not just the FSA that should go, it's the Bank of England as well, but that'd give the politicians less toys to play with.

An interesting thought piece. The gold standard is a single solution to all those problems. Or at least close as you can get, seeing as it is impossible to change human morality.

Gold standard =- No inflation- No interest rate fixing, just one steady low rate- The pounds you borrow now have to be paid back in exactly the same pounds later therefore no incentive to overborrow to take advantage of inflation- Banks only lend what they have- Saving is more desirable in low-risk non-house vehicles because there is no inflation premium- Capital formation improves due to low interest rates and less misallocation of capital.

All good intentions, and if I ruled the world they'd be enacted. In a world where benefit fraudsters are hounded, the dim chancing bankers will get away scot free. Just one caveat; idle land/ You have to allow for set aside for environmental reasons.Penny Rentergirl

Alice, this is a *SUPERB* piece. I think you should submit it to publishers for inclusion in Sunday papers.

Man-in-a-Shed. I've read your blog entry, and I broadly agree... Curiously, I think the wealthiest American investors agree too, though they see a different resolution. It is possible to argue that the debt was taken on knowingly - and that what is missing is education. That's fair, to some extent... for example, I actually believed, until early 2007, that debt and money would be equal in any currency - since, when money is borrowed, it is spent - not destroyed. Noticing that securitisation breaks that world model was, for me, a Eureka moment... and I seriously wonder what proportion of our so-called rational population grasp this.

My personal issue with the education argument is that, now I know how securitisation influences the economy, I've still no idea what should be done about it. It has debased our currency... and when that has happened in the past, only warfare seems to have been an effective resolution. War doesn't seem a credible strategy today... there's no obvious enemy. In my more speculative moments, I wonder if this war is the one terrorists think they are fighting.

My instinct is that "re-opening the markets for asset backed securities" is definitely a terrible idea... but, similarly, allowing existing securities to collapse would also be a tragedy for those ill-informed innocent people who allowed their pensions to be invested in them. Maybe securitisation needs to be regulated? I'm opposed in principle to the idea of assets bought with debt secured on those assets... maybe this holds the key? If houses could not be confiscated when mortgage holders default, that would likely encourage far more careful lending... while protecting the liberty of debtors.

It is a messy can of worms... with no single obvious solution. I really like Alice's recommendations - they sound positive and, potentially, the sort of thing that would represent a positive influence that could get political backing.

I think there's a lot to be said for hard money like gold backed money, but whoever thinks it would guarantee steadily low interest rates is very, very wrong.

The whole point of our fiat money system is to allow the central bank to artificially suppress the price of borrowing when they think the economy needs stimulating with extra credit availability.

If we switched to the gold standard tonight at midnight, and allowed interest rates to represent the real balance of the demand for, and supply of, credit, then interest rates would skyrocket.

That's because the fundamental cause of this problem is that having a centrally planned price control has utterly warped the relationship between the demand for and supply of credit. The proposed reforms are mostly good, but they won't fix this problem.

The answer is to stop trying to centrally plan the price of borrowing money. It's causing essentially the same supply distortions the Soviet Union saw when they attempted to centrally plan the production of (and hence the price) of wheat, tractor tyres etc..

I really dont think that replacing Victorian housing with "high density" housing is a viable solution on a social scale, didnt we try and do this in the 60's and we ended up tearing them all down again in the 80' and 90's? Weve been here before, take a look at "new builds" these days, shoddy substandard "slave boxes" that are not even good enough to be considered by housing associations as viable stock.

Although the vast majority of run down Victorian housing should be rebuilt or modernised, we really do not want to replace them with worse stock. at least the Victorians provided spacial living arears with gardens!.

The land use scandal needs to addressed, we have plenty of land that is just sitting there not being used in agriculture or other essential use that can easily be built on providing plenty of cheap homes, the whole land shortage argument is a myth perpetuated by the govt and property VI's and of course the greedy building firms that are thankfully now being hoisted on their own petards.